What Happened to Terra LUNA And Can It Be Salvaged?
The cryptocurrency markets have been taking a beating of late. You could even say crypto is crashing right now. But no token has taken a beating quite the Terra LUNA token. Less than a month ago, it was trading near $100 a token. But in the past week, it’s lost around 98% of its value. So what happened to Terra LUNA? It’s complicated.
The Terra LUNA plummet took place in conjunction with Terra’s stablecoin TerraUSD (UST) fall from grace. The beauty of stablecoins is they’re supposed to remain steady. They’re usually backed (or pegged) to an underlying asset. That’s why for the past year, TerraUSD’s value has remained steady at $1 worth of Terra LUNA per token.
However, something went very wrong. Conspiracies are circulating rapidly. Some have blamed the hedge fund Citadel and investment firm Blackrock, which has only recently gotten involved in crypto. The theories claim that the two colluded to what amounts to market manipulation. But we’re not too interested in that until we see some actual proof.
The fact of the matter is Terra LUNA plummeted in devastating fashion. And because Terra LUNA acts as one of the currencies backing TerraUSD it too took a significant nosedive.
This is bad news for two reasons. For starters, Terra LUNA’s collapse shows the fragility of the crypto markets as a whole. And it may also be a red flag pointing towards the manipulation that is possible. On top of this, the TerraUSD drop also showcases the trouble with stablecoins as a whole.
What Happened to Terra Can Happen Again
We’ve been warning of the dangers of some stablecoins for a while now. We’re not going to pretend we predicted what happened to Terra and its network’s two main tokens. But it is symptomatic of a larger issue.
Our gripes came after Caitlin Long – the CEO of Avanti Bank & Trust, which specializes in digital assets – uncovered a problem about the world’s largest stablecoin, Tether. She revealed that most of the U.S. dollars the stablecoin Tether was backed by actually consisted of “commercial paper.”
This is a big deal because commercial paper is a riskier asset than Treasury bills. You can read Long’s analysis in the thread linked below. That makes the possibility of Tether defaulting much higher than if it were pegged to actual U.S. dollars.
Long’s finding triggered a substantial selloff of those looking to reduce exposure to stablecoins. But this isn’t what happened to Terra LUNA or TerraUSD. It’s just a warning. What went haywire for Terra was a massive selloff of TerraUSD on several exchanges at the same time. And at the same time, major short positions were taken against Terra Luna.
By the time investors woke up on May 8, an estimated 286 million TerraUSD tokens were sold. And this paired with the short positions caused the algorithm that keeps TerraUSD to become unbalanced. In other words, it was unpegged. It fell below $1. That triggered a much larger selloff. And by the time the dust settled, roughly $11 billion of Terra LUNA’s market cap was erased. That’s essentially what happened to Terra and its two tokens.
Is Terra LUNA Done For?
What went wrong is people lost confidence in this system that had been working. A whole lot of investors dumped both Terra LUNA and TerraUSD. That opened up a chance for arbitrage trading. Some savvy folks stepped in, bought TerraUSD for less than $1, then exchanged it for $1 worth of Terra LUNA. They then sell their Terra LUNA tokens on the market. And that further drove down the price.
Because there is no built-in way to stop this, the price just kept falling further and further with each arbitrage trade. And in the process a whole lot of retail investors with a stake in Terra LUNA took a bath.
But Terra founder, Do Kwon hasn’t given up yet. He’s been listening to the Terra community. And he’s looking to make things right again. Hopefully with a better idea of how to prevent this from happening again.
2/ I understand the last 72 hours have been extremely tough on all of you – know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this.
— Do Kwon 🌕 (@stablekwon) May 11, 2022
After a few days of quiet, Kwon announced his plan. “The only path forward will be to absorb the stablecoin supply that wants to exit before $UST can start to repeg. There is no way around it.” He also announced that he would adopt the community’s proposal 1164.
If the plan is enacted, it would increase the minting capacity of Terra LUNA from $293 million to more than $1.2 billion. And more Terra LUNA being minted and sold will hopefully return TerraUSD to $1.
The Bottom Line on What Happened to Terra
It’s going to take a long time for Terra to regain the trust of investors. And as of right now, there doesn’t seem to be anything in place to keep what happened to Terra LUNA and TerraUSD from happening again. And that should worry folks.
Furthermore, a coordinated selloff like this could happen to other cryptos as well… Especially now that folks know how successful and lucrative it can be. This makes what happened to Terra all the more troublesome. On top of this, it was devastating to a lot of Terra LUNA investors.
The Terra LUNA subreddit is currently filled with heartbreaking stories of folks losing more than they could afford to lose. It’s so bad that they’ve pinned national helpline numbers to the top of the subreddit. While this is no time for a told-you-so, it should be an important reminder to others to diversify. And never invest more than you can afford to lose… Especially in an asset as speculative and uncertain as cryptocurrency.
About Matthew Makowski
Matthew Makowski is a senior research analyst and writer at Investment U. He has been studying and writing about the markets for 20 years. Equally comfortable identifying value stocks as he is discounts in the crypto markets, Matthew began mining Bitcoin in 2011 and has since honed his focus on the cryptocurrency markets as a whole. He is a graduate of Rutgers University and lives in Colorado with his dogs Dorito and Pretzel.